Sometimes it isn’t a company’s underlying business that causes its stock to roar. Sometimes it is just pure momentum, sometimes it is wildly unrealistic expectations and sometimes it is a combination of overzealous short-selling and financial engineering. That’s what is happening with Restoration Hardware (NYSE:RH), and there’s another 50 points of upside left in RH stock.
Back in May, the Board of Directors at RH granted CEO Gary Friedman a very enticing package. He gets awarded 1,000,000 shares of RH stock at $50 per share, and those shares vest once the stock reaches $100, $125 and $150.
That means that if the stock hits $150 before next May, the grant is worth $100 million five years from now.
Thus, Friedman has every incentive to push RH stock to $150. It already rose from the mid-$40s to $100 since late August. Two days after this deal was struck, RH announced a $700 million share buyback, at a time when almost 60% of the float was short.
Half of the outstanding shares have already been repurchased and the buyback has already been completed. Any bit of good news will send the stock higher, and shorts will be caught in a squeeze. RH reports earnings on Tuesday.
In its last earnings report in September, by beating earnings, RH stock increased from $50 to $70 in just one day. Revenues climbed 13%, EPS exploded by almost 50%, and management boosted both revenue and net income guidance.
Retail has been performing slightly better than expected, as long it doesn’t involved clothing. RH is, of course, a high-end furniture retailer. With the stock market at all-time highs, the stage is set for a good report.
Friedman is also being very direct about how RH is using capital. Here’s what he said in September:
“Our efforts to optimize inventory and reduce capital spending generated $282 million of free cash flow in the first six months of 2017, and we now expect to generate approximately $400 million of free cash flow for the year, which should address any concerns about our balance sheet and debt ratios. We have reinvested the $282 million of free cash flow generated in the first half, and the $263 million of cash and investments on our balance sheet at the beginning of the year towards the repurchase of our stock, which we believe is an excellent allocation of capital for the long-term benefit of our shareholders.”
So this is important even from a fundamental standpoint. He is doing what a good CEO should do anyway. For starters, he is reworking the supply chain. RH is also subdividing itself to focus on specific consumers with its RH Modern, RH Teen and RH Hospitality brands.
RH should also start to see accretive effects from its purchase of Waterworks – an upscale home accessories brand that RH scooped up for a mere $117 million.
I think the play here is to buy some RH stock and wait until June to see how this plan plays out. Drawing down more debt to fund another buyback should be coming soon, given that the first buyback has been profoundly successful.
It seems to me that with $100 million on the line, the CEO is going to pull out all the stops to get RH stock moving.
[Editor’s note: This story was corrected to fix a mistake that inaccurately cited CEO Gary Friedman’s grant as $500 million.]
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He owns shares of RH. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at [email protected].